"...emerging markets will grow faster than the
developed world for decades to come."

Gideon Rachman, The Financial Times

A Fed Move Could Be Good News for Emerging Markets

A Fed Move Could Be Good News for Emerging Markets

After months (if not years) of speculation and debate, the US Federal Reserve (Fed) has left the financial markets in a holding pattern once again, deciding to keep its benchmark short-term interest rate steady at near zero. In our view as investors in emerging markets, this isn’t necessarily positive news, because we are still left with the uncertainty that has been plaguing the market for some time. We know that the markets dislike uncertainty, so we could also be left with continued volatility through year-end.

At the conclusion of its two-day policy meeting on September 17, the Fed left the federal funds rate unchanged, citing low inflation and instability in the global economy. I believe that once the Fed does take action it will not be the start of an aggressive tightening regime. With other central banks around the world moving in the opposite direction—lowering interest rates—the Fed can’t have too strong an impact and is likely to be extremely cautious and incremental with any future actions. My feeling is that the underperformance in emerging markets overall this year can be partly attributed to the uncertainty about interest rates. We saw a similar type of downturn in emerging markets two years ago, when the Fed first started hinting at increasing interest rates—which was dubbed the “taper tantrum.”

Some commentators have stated that emerging markets have entered a vicious cycle of capital outflows, currency weakness and liquidity with higher interest rates, which has resulted in weaker growth. This, in turn, has prompted more capital outflows, feeding into a negative loop.

On the other side of this equation are the positive aspects. If in coming months the Fed feels confident enough in the US economy to raise interest rates, it could be viewed as positive news for emerging markets, particularly those with export ties that benefit from a strengthening US economy. We would anticipate a stronger US economy would likely bring increased demand for more imported goods, and a stronger US dollar relative to other emerging market currencies could put emerging markets in a more favorable trade position. Weaker currencies tend to promote exports and help manufacturers.

In contrast to the Fed, central banks in emerging markets generally are not considering the question of raising interest rates in their home countries. The largest—China—has been working to stimulate its economy through lower interest rates and other measures. We generally see lower inflation and, therefore, lower interest rates in emerging markets going forward, despite the threat of future US interest rate actions. At the government level, emerging market government bonds in many cases are seeing higher yields, but this phenomenon does not necessarily carry through to the private sector.

To us, the key question for equity investors in all this news is, where does value lie? With the downturn this year in emerging markets generally, equity valuations have become more attractive, with declining price-earnings ratios.1 Of course, with the low interest rates that we have seen, average price-earnings ratios have been moving up in the past few years. Only recently, with the downturn in the markets, have we seen more reasonable ratios. However, in many cases they tend to be high by historical standards, and therefore a careful stock selection program is necessary in our view.

With the slowdown of economic growth in China, we have also seen a deceleration of imports, although imports are still substantial not only for China but for all emerging markets. It’s important to note that the value of imports for certain commodities may be down since commodity prices have fallen in US dollars but the quantity may not have declined. In the case of China, its major imports are materials such as metals, chemicals and other crude materials including iron ore, which represent almost 30% of total import value, followed by industrial machinery at 26% and energy imports, including coal, oil and gas, at about 14%.2 Exporters of those items are therefore likely to be impacted by China’s slowdown, although as noted, further improvement in the US economy should be welcome news to help buoy these industries going forward—and help stabilize global markets generally.

In our view, a series of rapid or large interest rate increases could further destabilize the markets over the longer term, but as stated, we don’t see that as a likely course. We would also emphasize that while some recent market shocks have been unsettling to many investors, volatility goes both ways—we could see equally sharp rebounds in equity markets take hold and asset flows shift as more positive events unfold.

Mark Mobius’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.

Important Legal Information

All investments involve risks, including the possible loss of principal. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in emerging markets, of which frontier markets are a subset, involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Because these frameworks are typically even less developed in frontier markets, as well as various factors including the increased potential for extreme price volatility, illiquidity, trade barriers and exchange controls, the risks associated with emerging markets are magnified in frontier markets. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions.

_______________________________________

1. The price-to-earnings (P/E) ratio is the current market price of a company share divided by the earnings per share of the company.

2. Source: National Bureau of Statistics of China, 2014.

Mark Mobius

Mark Mobius

Mark Mobius, Ph.D., executive chairman of Templeton Emerging Markets Group, joined Templeton in 1987. Currently, he directs the Templeton research team which is based in 18 global emerging markets offices, and manages emerging markets portfolios. Dr. Mobius has been investing in global emerging markets for more than 40 years and has received numerous industry awards, including being named one of Bloomberg Markets Magazine’s “50 Most Influential People” in 2011.


Related Articles

Poland’s Growing Prosperity

When I first traveled to Warsaw over 20 years ago, it was a grey and forbidding place with drab shop

Vietnam expected to be the next Asian tiger

Despite concerns about corruption, bureaucracy and a weak legal framework, Vietnam’s growth is based on sound fundamentals Vietnam is regarded

Chinese economic growth stimulated by liquidity boost

The People’s Bank of China, the country’s central bank, is injecting $81 billion dollars into the economy to stimulate Chinese

5 comments

Write a comment
  1. Mark
    Mark 20 September, 2015, 18:01

    Well balanced.

    Reply this comment
  2. J. Slater
    J. Slater 20 September, 2015, 18:01

    I am guessing we will continue to see uncertainty in the markets

    Reply this comment
  3. Ahad
    Ahad 20 September, 2015, 18:02

    I agree, The key has always been valuations

    Reply this comment
  4. Selma
    Selma 20 September, 2015, 18:03

    Lower interest rates do support an already weakened economy. It will all boil down to valuations and upside potential

    Reply this comment
  5. Taylor
    Taylor 20 September, 2015, 18:04

    China is well positioned for this. Exports are key. Lets see what happens to the yuan in the next few months.

    Reply this comment

Write a Comment

Your e-mail address will not be published.
Required fields are marked*